Chapter 5: SupplyChapter 5: SupplySection 2Section 2

Slide 2Copyright © Pearson Education, Inc.Chapter 5, Section 2

ObjectivesObjectives

1. Explain how firms decide how much labor to hire in order to produce a certain level of output.

2. Analyze the production costs of a firm.

3. Explain how a firm chooses to set output.

4. Identify the factors that a firm must consider before shutting down a profitable business.

Slide 3Copyright © Pearson Education, Inc.Chapter 5, Section 2

Key TermsKey Terms

• marginal product of labor: the change in output from hiring one additional unit of labor

• increasing marginal returns: a level of production in which the marginal product of labor increases as the number of workers increases

• diminishing marginal returns: a level of production in which the marginal product of labor decreases as the number of workers increases

• fixed cost: a cost that does not change, no matter how much of a good is produced

Slide 4Copyright © Pearson Education, Inc.Chapter 5, Section 2

Key Terms, cont.Key Terms, cont.

• variable cost: a cost that rises and falls depending on the quantity produced

• total cost: the sum of fixed costs plus variable costs

• marginal cost: the cost of producing one more unit of a good

• marginal revenue: the additional income from selling one more unit of a good

• average cost: the total cost divided by the quantity produced

• operating cost: the cost of operating a facility

Slide 5Copyright © Pearson Education, Inc.Chapter 5, Section 2

Labor and OutputLabor and Output

• All business owners must decide how many workers they will hire.

Slide 6Copyright © Pearson Education, Inc.Chapter 5, Section 2

Marginal ReturnsMarginal Returns

• The addition of more workers to a firm allow for a greater amount of specialization.

– Specialization increases the output and the firm enjoys increasing marginal returns.

Slide 7Copyright © Pearson Education, Inc.Chapter 5, Section 2

Marginal Returns, cont.Marginal Returns, cont.

– A firm with diminishing marginal returns will produce less and less output from each additional unit of labor.

Slide 8Copyright © Pearson Education, Inc.Chapter 5, Section 2

Fixed CostsFixed Costs

– Fixed costs mainly involve the production facility and include:

• Rent• Machinery repair• Property taxes• Worker’s salaries

Slide 9Copyright © Pearson Education, Inc.Chapter 5, Section 2

Variable CostsVariable Costs

• Variable costs include:– Price of raw materials– Some labor– Electricity and heating

bills

• Fixed costs and variable costs are added together to find the total cost.

Slide 10Copyright © Pearson Education, Inc.Chapter 5, Section 2

Setting OutputSetting Output

• .

Why is the marginal revenue always equal to $24?